4 ms·

> a couple folks I know held Zynga shares at the point where the company went public and they ended up with a massive tax bill that they couldn't sell shares to

> a couple folks I know held Zynga shares at the point where the company went public and they ended up with a massive tax bill that they couldn't sell shares to pay off. What exactly is the combination of factors that produces that outcome?

kevingadd 11y ago
When you convert your options to shares you pay the taxes. I'm not sure precisely why they converted at that point in time; it's possible it was in their employment agreements or part of the terms of the IPO. It may have been as simple as 'this stock price is going to go up after we go public, so it's in your best interest to buy the shares now'.
- Florin_Andrei 11y ago
  > It may have been as simple as 'this stock price is going to go up after we go public, so it's in your best interest to buy the shares now'. That's what I thought. Exercised too early.
jpdaigle 11y ago
Could be a 6 month lock-up period during which the employees who exercised and now hold stock (and thus have a huge tax liability) cannot trade (buy or sell) in the stock. So for 6 months you can be entirely at the mercy of the public markets, watching helplessly from the sidelines as the price crashes. (And yes, the solution is to not exercise until you're able to sell.)
- georgemcbay 11y ago
  I have no knowledge of Zynga, but this is exactly what I've seen happen in other instances. Lock-up period combined with people exercising ASAP to optimize for reduced capital gains taxes due to the one year window between exercising and selling. The fear of paying more taxes (or waiting longer for the 1 year period after exercising) causes a significant amount of people to expose themselves to a potentially devastating downside by exercising ASAP. While this seems like a silly thing to do (and it is, IMO) it has to be seen in the context of a company full of people experiencing (often for the first time) what seems like it will be a very successful "exit" and everyone in the company is in euphoria mode, counting their Lamborghinis before they are hatched. Of course, after you see the results of this happening the first time you get to be the Debbie Downer who warns people of the possible downside in subsequent companies. IME this is a tough position to be in because you look like a negative asshole when everyone else is in party mode (often being egged on by upper management selling the dream).
- lutorm 11y ago
  Well, in this case arguably the solution is not to exercise if you can't pay the tax bill, absent selling your stock. Exercise early, pay little tax because the FMV is low. Exercise late, pay lots of tax because the FMV is high. Exercise late and sell, pay lots of short-term cap gains tax. Exercising late, while still unable to immediately sell some shares to cover the tax bill you know will come seems like taking a huge risk.
bwoj 11y ago
I worked for a company that went public at $18/share in 2000. During the lockup period the price of the stock went as high as $202/share. Over the next two years, the price trended downwards to around $20/share. Pre-IPO employees were encouraged to pay for shared before they vested. The idea here is that you can hold those options for 5 years and get capital gains rates on that appreciation which for small companies was 10%. I.E, you pay now, shares vest later. According to the AMT, you will owe taxes on those shares equal to the market price when they become yours minus what you paid for them. That is, when the stock vests. Not when you pay for it, and not when you sell it. So you can buy 1000 pre ipo shares for $1 each. Company goes public hits $100/share. You think it's going higher so you hold. Shares drop to $10. Now you're in a pickle. You owe taxes on 1000 shares * $99 of gain. But you're only sitting on 1000 shares * $9 of gain. When somebody finds themselves in this situation, they must sell those shares before that tax year ends, which means you're now paying income taxes instead. If your tax year has ended you are out of luck. The one thing that stops this from being a real problem for most founders is the IRS 83(b) form, which is to notify the IRS that you want to recognize the income associated with your option when you buy it as opposed to the default which is when it vests. Why doesn't everyone file their 83(b)? Clearly, the risk here is too complicated for many to understand and it's a very unusual situation to arise. Here is the story of how our CFO(!) at that company ran into this exact problem to the tune of $316,040 tax liability for shares he bought with money borrowed from the company(!): https://www.washingtonpost.com/archive/business/2000/07/02/keep-the-tax-man-away-from-your-stock-option-gains/7070006d-f6ee-47c1-97d9-ae98c540e2c7/ https://www.washingtonpost.com/archive/business/2000/07/02/k... Some references: https://www.nceo.org/articles/stock-options-alternative-minimum-tax-amt https://www.nceo.org/articles/stock-options-alternative-mini... https://blog.wealthfront.com/always-file-your-83b/ https://blog.wealthfront.com/always-file-your-83b/

kevingadd 11y ago

When you convert your options to shares you pay the taxes. I'm not sure precisely why they converted at that point in time; it's possible it was in their employment agreements or part of the terms of the IPO. It may have been as simple as 'this stock price is going to go up after we go public, so it's in your best interest to buy the shares now'.

Florin_Andrei 11y ago
> It may have been as simple as 'this stock price is going to go up after we go public, so it's in your best interest to buy the shares now'. That's what I thought. Exercised too early.

jpdaigle 11y ago

Could be a 6 month lock-up period during which the employees who exercised and now hold stock (and thus have a huge tax liability) cannot trade (buy or sell) in the stock. So for 6 months you can be entirely at the mercy of the public markets, watching helplessly from the sidelines as the price crashes. (And yes, the solution is to not exercise until you're able to sell.)

georgemcbay 11y ago
I have no knowledge of Zynga, but this is exactly what I've seen happen in other instances. Lock-up period combined with people exercising ASAP to optimize for reduced capital gains taxes due to the one year window between exercising and selling. The fear of paying more taxes (or waiting longer for the 1 year period after exercising) causes a significant amount of people to expose themselves to a potentially devastating downside by exercising ASAP. While this seems like a silly thing to do (and it is, IMO) it has to be seen in the context of a company full of people experiencing (often for the first time) what seems like it will be a very successful "exit" and everyone in the company is in euphoria mode, counting their Lamborghinis before they are hatched. Of course, after you see the results of this happening the first time you get to be the Debbie Downer who warns people of the possible downside in subsequent companies. IME this is a tough position to be in because you look like a negative asshole when everyone else is in party mode (often being egged on by upper management selling the dream).
lutorm 11y ago
Well, in this case arguably the solution is not to exercise if you can't pay the tax bill, absent selling your stock. Exercise early, pay little tax because the FMV is low. Exercise late, pay lots of tax because the FMV is high. Exercise late and sell, pay lots of short-term cap gains tax. Exercising late, while still unable to immediately sell some shares to cover the tax bill you know will come seems like taking a huge risk.

bwoj 11y ago

I worked for a company that went public at $18/share in 2000. During the lockup period the price of the stock went as high as $202/share. Over the next two years, the price trended downwards to around $20/share. Pre-IPO employees were encouraged to pay for shared before they vested. The idea here is that you can hold those options for 5 years and get capital gains rates on that appreciation which for small companies was 10%. I.E, you pay now, shares vest later. According to the AMT, you will owe taxes on those shares equal to the market price when they become yours minus what you paid for them. That is, when the stock vests. Not when you pay for it, and not when you sell it. So you can buy 1000 pre ipo shares for $1 each. Company goes public hits $100/share. You think it's going higher so you hold. Shares drop to $10. Now you're in a pickle. You owe taxes on 1000 shares * $99 of gain. But you're only sitting on 1000 shares * $9 of gain. When somebody finds themselves in this situation, they must sell those shares before that tax year ends, which means you're now paying income taxes instead. If your tax year has ended you are out of luck. The one thing that stops this from being a real problem for most founders is the IRS 83(b) form, which is to notify the IRS that you want to recognize the income associated with your option when you buy it as opposed to the default which is when it vests. Why doesn't everyone file their 83(b)? Clearly, the risk here is too complicated for many to understand and it's a very unusual situation to arise. Here is the story of how our CFO(!) at that company ran into this exact problem to the tune of $316,040 tax liability for shares he bought with money borrowed from the company(!): https://www.washingtonpost.com/archive/business/2000/07/02/keep-the-tax-man-away-from-your-stock-option-gains/7070006d-f6ee-47c1-97d9-ae98c540e2c7/ https://www.washingtonpost.com/archive/business/2000/07/02/k... Some references: https://www.nceo.org/articles/stock-options-alternative-minimum-tax-amt https://www.nceo.org/articles/stock-options-alternative-mini... https://blog.wealthfront.com/always-file-your-83b/ https://blog.wealthfront.com/always-file-your-83b/